War-Gaming Greek Euro Exit Shows Hazards in 46-Hour Weekend
Greece may have only a 46-hour window of opportunity should it need to plot a route out of the euro.
That’s how much time the country’s leaders would probably have to enact any departure from the single currency while global markets are largely closed, from the end of trading in New York on a Friday to Monday’s market opening in Wellington, New Zealand, based on a synthesis of euro-exit scenarios from 21 economists, analysts and academics.
Over the two days, leaders would have to calm civil unrest while managing a potential sovereign default, planning a new currency, recapitalizing the banks, stemming the outflow of capital and seeking a way to pay bills once the bailout lifeline is cut. The risk is that the task would overwhelm any new government in a country that has had to be rescued twice since 2010 because it couldn’t manage its public finances.
“Leaving is difficult and messy, so anyone who thinks it’s easy is just wrong,” said Lorenzo Bini Smaghi, who left the European Central Bank’s executive board last year, in a phone interview. “The Greeks must be rational and protect themselves from rash decisions that they will live to regret. Leaving the euro is not the answer to their problems.” He declined to say whether he thought an exit would occur.
The specter of Greece leaving the euro was evoked when ECB executive board member Joerg Asmussen told Germany’s Handelsblatt in an interview published May 8 that Greece couldn’t renegotiate its bailout terms if it wanted to stay in the euro. President Mario Draghi responded May 16 that the ECB’s “strong preference” was for Greece to stay in the euro.
The remarks followed elections May 6 that propelled the Syriza party, which calls for reneging on the bailout accords, into second place. Syriza may build on that support in June 17 elections, according to three opinion polls, complicating Greece’s efforts to avoid running out of cash by early July.
Syriza’s opposition to the terms of Greece’s financial-aid program doesn’t mean the country would have to abandon the euro should the party form a government after the elections, party leader Alexis Tsipras said May 20. The Pasok Socialist party and the New Democracy party, which have taken turns running Greece over the past four decades, favor meeting the bailout terms.
First in Century
“This is the first time since the beginning of the last century that it’s not about the left or right winning, it’s about pro-bailout or anti-bailout,” said Aristotle Kallis, professor of modern and contemporary history at Lancaster University in the U.K.
European leaders meeting today in Brussels are seeking to keep Greece within the 17-nation single currency as new French President Francois Hollande and German Chancellor Angela Merkel disagree on how much austerity is needed to stem the crisis.
“We don’t think Greece will walk away, even if the result after the June 17 election is difficult for the pro-bailout parties,” he said in a May 21 interview on Bloomberg Television’s “The Pulse” with Maryam Nemazee. “We don’t think they will deliberately step away from the bailout. There will be a process of negotiation in a worst-case scenario, but we don’t believe a Greek exit is going to happen.”
Still, Citigroup Inc. economists said in a May 7 research note that Greece’s election results increase the risk of the country leaving the euro within the next year to 18 months to as high as 75 percent. More than 50 percent of investors surveyed by Bloomberg News predict an exit of a euro member this year.
A euro exit could be in the cards almost as soon as the new government is formed should new leaders decline to adhere to the bailout terms of spending cuts and economic modernization, said Marco Annunziata, a former International Monetary Fund executive who now works as chief economist at General Electric Co. (GE) in San Francisco.
“Time is of the essence,” he said in a telephone interview. “Events may unfold faster than we expect. The key risk is that anti-reform statements by a new government might trigger a run on deposits.”
Such a run could induce the ECB as early as the following Friday to cut off further funding to Greek banks at a time when the government lacks money to recapitalize them, said Carsten Brzeski, a former European Commission economist who now works for ING Group in Brussels.
With further bailout payments suspended by EU leaders to await the government’s direction and the country’s coffers expected to run out of cash within two months, Greece’s options would begin to narrow.
A new government may have to respond with capital controls to prevent citizens, faced with potential devaluation of their savings, from withdrawing their money from banks, said Dawn Holland, a senior research fellow at the National Institute of Economic and Social Research in London.
“This has to happen very quickly, as capital flight has already happened,” she said. “This is when things could get ugly too, as on an individual basis you cannot blame people for wanting to hold on to their euros.”
Greek bank deposits dropped about 23 billion euros ($29 billion) in the nine months through March, or about 13 percent, to about 160 billion euros, central bank data show. President Karolos Papoulias said on May 14 that about 700 million euros had been withdrawn, without specifying over how many days.
Stocks fell in Asia today amid concern at the dangers posed by any Greek departure from the euro, with the MSCI Asia Pacific Index losing 1.6 percent as of 2:17 p.m. in Tokyo. The euro was little changed at $1.2673. Former Greek Prime Minister Lucas Papademos said an exit for his nation would be “catastrophic” and have implications for the euro region, the Wall Street Journal reported, citing an interview.
“Although such a scenario is unlikely to materialize and it is not desirable either for Greece or for other countries, it cannot be excluded that preparations are being made to contain the potential consequences of a Greek euro exit,” the Wall Street Journal quoted Papademos as saying. CNBC television separately quoted Papademos as saying there aren’t preparations underway in Greece for a euro exit.
Should the country’s officials ultimately decide to follow that path, Greece would have to request a meeting of euro-area finance ministers and leaders to set the exit conditions.
New York Close
The departure preparations could come as soon as the New York bond market’s close for the weekend at about 5 p.m. on a Friday. That’s 11 p.m. in Frankfurt and Brussels, home to most European institutions, and midnight in Athens.
“We have to assume that some plans have already been made,” said Gabriel Stein, a director at Lombard Street Research in London. “If not, people at the IMF and the ECB are failing in their duties to shareholders and taxpayers.”
European Union Trade Commissioner Karel de Gucht told De Standaard in an interview published May 18 that European officials are already working on contingency plans.
An ECB spokeswoman who declined to be named reiterated the central bank’s policy of not commenting on emergency plans or possible scenarios.
Central bankers in Europe have already started discussing the possibility of a Greek exit from the euro area and how to handle its fallout, Swedish Riksbank Deputy Governor Per Jansson told Bloomberg News in an interview May 11.
A Greek exit from the euro could be “technically” managed, ECB Governing Council member Patrick Honohan, who analyzed the breakup of the currency union between Ireland and the U.K. in a 1984 research paper, said in a speech in Estonia’s capital, Tallinn, on May 12. It “is not necessarily fatal, but it is not attractive.”
To stem any dollar shortages as a result of market panic, other central banks including the U.S. Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank probably would stand ready with swap lines augmented after the bankruptcy of Lehman Brothers Holdings Inc. in 2008.
On Saturday, finance ministers could converge on Brussels to prepare for the leaders’ summit on Sunday in which Greece’s exit plan would be finalized, Brzeski predicted.
He said he expects the best Greece can hope for is a one- time loan to soften the economic shock even as it pursues aid possibilities from the IMF.
“Europe is likely to throw them a few bones to ensure they’re not kicking the country out like a stray dog,” Brzeski said.
While Greek officials negotiate in Brussels, lawmakers in Athens may announce on the Saturday that they plan to issue a new currency, likely to be called drachma. Like its predecessor it would float freely in the market. Banks, meanwhile, would be instructed to redenominate all assets and liabilities, including bank accounts, wages and outstanding debt, according to the exchange rate chosen.
“A country leaving the euro zone should introduce its new currency at parity with the euro,” Capital Economics economists led by Roger Bootle wrote in a paper submitted for the 2012 Wolfson Economics Prize. “This would not only avoid the temptation for retailers to round up but also make clear to consumers that this had not been the case, and promote acceptance and understanding throughout the economy.”
At that time, the government could also commission a new set of banknotes and coins.
De La Rue Plc (DLAR), a U.K. company that prints notes for more than 150 countries, is already preparing for a reintroduction of the drachma, the London-based Times newspaper said on May 18. The company has asked production staff to choose potential security threads for use in new banknotes and has retrieved covers from an old collection of copper molds, used for watermarks, the newspaper said, citing people it didn’t name.
De La Rue declined to comment on the newspaper report.
Until the new notes and coins are delivered, euros might still be used for small purchases, while the share of electronic payments, such as bank transfers, and credit or debit card transactions, would increase as people try to save their euros, according to Lombard Street’s Stein.
At the same time, the country may deploy its military as soon as early morning Saturday and close its borders, preparing to stamp euros into drachma as an interim solution once a public announcement has been made, Holland and Brzeski said.
Greece would most likely also default immediately on its 280 billion euros of debt and find itself cut off from funding options that normally include IMF aid and the capital markets, according to Charlotte Gaitanides, head of European Studies at the University of Flensburg in Germany.
“Greece’s economy is still uncompetitive,” she said in a telephone interview. “The low value of the new currency will almost inevitably bring about a massive balance of payments deficit. So that means the country will have to go to the IMF.”
Negotiations with the IMF would probably drag on for most of the weekend, with Greece trying to win compromises over implementing budget cuts. The IMF likely would seek the strictest possible conditions for aid from a country that has violated past terms, to ensure the support of poorer, emerging- market shareholders.
The IMF has to be “technically prepared for anything because it’s our job,” Managing Director Christine Lagarde said in an interview with Dutch public television broadcast on May 16. “I’m not suggesting that this is a desirable solution. I’m just saying that this is within the range of multiple options.”
European ministers, now seeking ways to keep Greece in the euro, would in an exit scenario also focus on whether the country can stay in the 27-country EU, which guarantees it tariff-free trade and the free movement of citizens and labor.
“Europe won’t retreat completely,” said Thomas Mayer, chief economist at Deutsche Bank AG in Frankfurt, in a phone interview. “The situation already is extremely unstable in Greece and the last thing lawmakers would want is Greece falling back into anarchy.”
The challenges of this historical undertaking may prove overwhelming to a brand-new government in a country that is already struggling with basic bailout conditions such as regular tax collection.
“I am completely convinced they could not orchestrate an orderly exit,” said Erik Nielsen, chief economist at UniCredit SpA in London. “This is a country that can’t implement laws, so how in the world are they going to secretly agree to print money, control the banks, control capital flows and think this is going to be orderly? It’s completely impossible.”
No matter how long the process takes, news may leak that Greece is preparing to leave monetary union, sending Greeks fearful for their savings into the streets. From that point, the national government and European authorities would be racing to finish negotiations, contain speculation and restore order before officially informing the public that the euro they knew was no longer there.
“There is no reason to think there won’t be riots and violence,” said Lefteris Farmakis, a strategist at Nomura International Plc in London. “It would be a pretty disastrous situation. People have no understanding of the consequences of a euro exit.”
As Sunday draws to a close in Europe and afternoon arrives on the U.S. East Coast, traders in Wellington, New Zealand, would be the first to face the opening of bond and currency markets at 7 a.m. local time on Monday.
“The whole world will be online when New Zealand opens up,” said Sean Keane, an analyst in Auckland at financial advisory group Triple T Consulting and former head of Asia- Pacific rates trading at Credit Suisse Group AG. “You’ll have every fund manager in New York on Sunday watching what’s going on.”
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